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Five Tips to Steer Clear of the Courthouse

How CPAs help companies reduce litigation through risk management.

AS PART OF THEIR RISK
MANAGEMENT strategy, companies
are increasingly hiring an array of
experts, including CPAs, to review their
policies and controls and scrutinize
internal procedures to help keep them out
of the courthouse.

CPAs ACCUSTOMED TO
ASSESSING controls can
recommend these “best practices” to
their clients: Incorporate ethics
policies into the company mission
statement; inform employees of
responsibilities through training,
procedure manuals and other internal
communications; conduct periodic reviews
of compliance programs to keep them
current; and have a senior executive in
charge of compliance and regulation to
signal the importance of corporate
integrity.

CPAs CAN ENCOURAGE
THEIR CLIENTS to include
arbitration clauses in their contractual
agreements or to select alternatives to
litigation when disagreements arise.

BESIDES RESOLVING
ECONOMIC DISPUTES, CPAs can
help companies protect themselves
against problems involving
discrimination in hiring and promotions,
sexual harassment allegations and
wrongful termination. In such cases,
CPAs can work closely with human
resources departments to identify
problems in advance.

CPAs STRUCTURE
ROYALTY PAYMENT agreements
for companies to avoid intellectual
property squabbles—an increasingly
common area of contention in the
technology and pharmaceutical fields.
CPAs can help their clients avoid
disputes by offering them simple payment
formulas that are easy to understand.

IF A BUSINESS SEES
CERTAIN SIGNS of weak
controls, it may be time to call on a
CPA consultant. Before a company chooses
such an expert to implement risk
management processes, it needs to
evaluate his or her credentials.

PAUL
SWEENEY is a freelance writer in Brooklyn,
New York. His e-mail address is pswe865002@aol.com
.

larmed at the rising toll of
litigation costs, more and more companies are
taking steps to stop lawsuits before they begin.
As part of their risk management strategies,
finance executives, internal auditors and risk
managers increasingly are turning to CPAs to
review policies and controls and scrutinize
internal procedures to help keep their companies
out of the courthouse. In 2000 when court costs,
attorneys’ fees, insurance premiums, payments to
claimants and “every other conceivable expense
were added up,” reports Loretta Worters, director
of media relations at the Insurance Information
Institute in New York, the legal tab hit $179
billion. How does a business distance itself from
legal problems? Here are some tips from CPAs who
work as litigation consultants on how they helped
their corporate clients identify issues and
implement strategies to manage risks and avoid
legal conflicts.

TIP 1: PROMOTE ETHICAL BEHAVIOR It was just one of those
serendipitous things, says Cheryl Sparkes,
CPA and partner in charge of litigation
advisory services at the New York office
of Ernst & Young LLP, referring to a
consumer products company’s retaining
E&Y for a fact-finding mission. The
client had asked the firm to settle a
dispute involving a disgruntled employee
who had accused a senior manager of taking
kickbacks from a vendor. Eventually the
manager was exonerated. But what Sparkes
saw at the company aroused concern. “The
manager was not taking kickbacks, but we
found the company lacked ethics policies,”
she says. “We discovered salaried
employees were working as consultants for
other companies. They weren’t doing
anything wrong, per se, but they were
exposing their employer to allegations of
self-dealing and conflicts of interest.”

Risk
Management Programs Need
Improvement In a study assessing
current practices, most (65%)
senior executives from 400
companies in a wide range of
industries said they lacked
confidence their risk management
programs identified and managed
all potentially significant
business hazards.

Because the CPA firm alerted it to the risks,
the company took action. Management instituted a
code of ethics as part of its efforts to ensure
good corporate governance. Now, Sparkes says, when
the company hires a salaried employee, he or she
agrees not to take on outside work lest there be a
conflict of interest. Moreover, employees are
required to shun improper relationships with
vendors, such as the accepting of gifts valued
above a certain dollar amount—“a trip to Hawaii,”
for example, says Sparkes. If employees become
compromised, a company may have to defend itself
against charges of restraint of trade,
self-dealing, failure to use competitive bidding
practices and even insider trading violations.

What began as a nasty episode, Sparkes says,
had favorable results. Not only was the manager
absolved of any wrongdoing, but the company—which
Sparkes describes as “young and successful” and
one that had planned to take care of back-office
issues “later rather than sooner”—dodged potential
legal and ethical bullets by tightening up its
internal controls.

Once a company has a
code of conduct in place, how does management
improve ethics awareness among employees? CPAs who
are accustomed to assessing controls can recommend
these “best practices” to their clients:

Incorporate ethics policies into the
company mission statement and publicize them to
employees.

Inform employees of responsibilities
through training, procedure manuals and other
internal communications.

Conduct periodic reviews of
compliance programs to keep them current.

Put a senior executive in charge of
compliance and regulatory matters to signal the
importance of corporate integrity.

TIP 2: ENCOURAGE ALTERNATIVE DISPUTE
RESOLUTION One way businesses reduce litigation costs
is to avoid going to court whenever possible. CPAs
can encourage their clients to include arbitration
clauses in their contractual agreements or to
select alternatives to litigation when
disagreements arise. Alternative dispute
resolution (ADR) methods, such as arbitration and
mediation, offer a variety of techniques for
resolving conflicts with the aid of a neutral
party and without resorting to litigation.
Arbitration and mediation provide timely and
economical results and are widely used to settle
business controversies without the delays and
public exposure of lawsuits. Thomas Emmerling,
CPA, managing partner and litigation consultant at
Dopkins and Co. in Buffalo, New York, advises
clients to include a demand for alternative
dispute resolution in contracts with suppliers and
vendors and adds that these agreements are
commonly used in many industries to handle
employment, labor and insurance issues.

Sometimes parties need ADR when other options
fail. For example, business interruption insurance
claims frequently require a loss appraisal
prepared by both the insurer and the insured. If
the valuators cannot agree on the amount of the
loss of business income due to the suspension of
operations, the parties may ask a CPA to serve as
a mediator to settle the claim. (For more details
on ADR, visit the American Arbitration Association
Web site at www.adr.org/index2.1.jsp
. For a look at how ADR works, see “ Stay
Out of Court ,” JofA, Sep.98, page
77.)

The insurance industry supports the
use of ADR by its policyholders as an economical
alternative to litigation. William Bailey, special
counsel to the Insurance Information Institute,
says providers of legal liability policies use a
system of discounts and rebates as an incentive
for companies to implement specialized training
and litigation prevention programs to address
ethical, contract and employment issues. “You’ll
find the insurance industry invests a lot of money
in loss prevention and mitigation of damages.
Insurers build discounts into the premium price
structure to encourage customers to
conscientiously avoid the risk of litigation,”
says Bailey.

TIP 3: ASSESS HR PROCEDURES In addition to helping companies resolve
economic disputes, CPAs can assist in protecting
them against problems involving discrimination in
hiring and promotions, sexual harassment
allegations and wrongful termination.
Well-developed hiring practices can be key to
blunting problems before they occur. While most
large companies likely have a well-trained human
resources department in place, the CPA can add
another pair of eyes to monitor the existing
system for any potential red flags. But it is at
small and medium-sized companies where a CPA can
really play an important role, says Grace Ghezzi,
a CPA at Green & Seifter in Syracuse, New
York. The CPA, accustomed to detecting problems,
is able to spot issues throughout an organization
before they arise and share insights and concerns
with owners and top managers, observes Ghezzi.
“The CPA is the one professional who sees
businesspeople every year, usually at tax time,”
she says. “I’ll ask my clients what they’re doing
in the areas of employment practices and controls,
hiring procedures and what policies are in place
to protect them from an unhappy employee. The CPA
can add awareness.”

By instituting an
effective screening process, companies can prevent
themselves from hiring persons with the potential
to engage in risky behavior, including drug and
alcohol abuse, fraud, theft and mismanagement.
CPAs can work closely with the human resources
department to make sure a company maintains a
state-of-the-art employee manual governing
employment policies and hiring procedures
including conducting background checks and
checking employee references, says Ghezzi. She
also recommends companies do a credit check,
particularly for persons working in sensitive
positions where they are collecting money or
writing checks. It may be necessary to insist that
persons in such positions permit ongoing credit
checks once they have been hired.

“The
Fair Credit Reporting Act imposes strict limits on
the ability of a company to do a credit check on
an employee without his or her permission,” she
says, “so it’s wise to get permission in writing
during the employment process.” Recently, Ghezzi
worked on a fraud case where the company suspected
someone was stealing cash. In such cases she
recommends reviewing the credit history to see
what the individual owns and owes. “If the person
is accumulating assets, which can be essential in
pinning down fraud, unless he can show he is the
recipient of an inheritance, he’ll have a lot of
explaining to do,” says Ghezzi. But in this
example the company hadn’t received permission to
do a criminal background check during the hiring
process and couldn’t conduct an investigation
without notifying the employee.

Another
important precaution for companies, advises
Ghezzi, is to have written policies specifying
hours of employment, holidays, grievance
procedures, and prohibitions against
discrimination on the basis of race, sex or age,
as well as detailed policies proscribing sexual
harassment. Ghezzi urges CPAs to suggest companies
secure written statements showing that employees
have been informed about such policies and
understand the consequences. The importance of
having written rules cannot be overstated. For
example, Ghezzi says she saw a company sued for
damages when one of its staff members had a
three-martini lunch and caused a car accident on
the way back to work. Because the company did not
have a “no drinking” policy in writing, it was
vulnerable in a civil lawsuit.

Furthermore, all employees and managers should
attend training sessions on workplace policies.
This allows an employer to demonstrate that, in
the case of a lawsuit, it did not just warn
employees and managers about inappropriate
behavior, but required training to help prevent
it. Ghezzi also recommends that companies provide
a hot line to make it possible for employees to
communicate problems anonymously.

TIP 4: EXAMINE CONTRACT LANGUAGE Most CPAs say their analytical expertise is
very attractive to businesses when dollar losses
are at stake. Thus companies are likely to summon
them to guard against cases involving fraud and
embezzlement and breach-of-contract and
intellectual property (IP) disputes. CPAs can
structure companies’ royalty payment agreements,
for example, to conform to the terms of the
licensing deal in order to avoid intellectual
property squabbles—an increasingly common area of
contention in the technology and pharmaceutical
fields (see “Techniques
to Turn Intellectual Property Into More
Profitable Assets,” JofA, Sep.01,
page 20).

Badly constructed royalty
agreements result in misunderstanding among
parties and lawsuits, says Christian Hughes, CPA,
partner at PricewaterhouseCoopers’ dispute
analysis and investigations practice in Boston.
Too often, he says, companies use a sloppy and
haphazard process to protect their intellectual
capital. “Very often we see people signing
agreements based on the last one they had and they
just change the names in the contract,” says
Hughes. “We see smaller companies start without
input from legal professionals or advisers with
business savvy, which is a good way to invite
lawsuits,” he adds. Simply employing a CPA with
real-world experience in IP matters can save
businesses a lot of “suspicion and confusion”
later.

One common area where lawsuits
arise, says Hughes, is in calculating royalties
derived from licensing IP. The terms of the
agreement can specify “10% of the profits” but in
practice the parties can interpret the term
profit differently. For example, an
inventor of a software program assumes it refers
to gross profits, only to find herself with little
or nothing because a licensee is paying 10% of
after-tax profits. Hughes observes the parties can
avoid a dispute simply by agreeing on a
noncontroversial payment formula that is easy to
understand. When Hughes’ firm helps clients
prepare such royalty contracts, it tries to
simplify the calculations by using 10% of the
amount shown (on line 36, for example) on the
client’s monthly income statements—a formula
Hughes calls “simplicity of verification.” He
suggests such precautions go far toward helping
clients avoid legal problems.

TIP 5: BE WILLING TO WORK WITH A THIRD
PARTY If a business sees certain signs such as
missing funds or critical documents or troublesome
customer complaints, it may be time to call on the
CPA litigation consultant. A former FBI agent who
is the regional director of forensic accounting at
a Big Five firm and who asked not to be named
says: “CPAs are trained to spot weak controls.
Management may have blinders on. Sometimes you
need a third party to look around and show that
bad decisions are being made.”

Before a
company chooses an outside expert to implement
risk management processes, it needs to evaluate
his or her credentials. Ghezzi says company risk
managers must be sure a CPA litigation consultant
has the right expertise, such as training in
interview techniques, and industry-specific
experience, particularly if the parties anticipate
the possibility of testifying in court.

For companies with foreign subsidiaries, CPAs
can offer their expertise to unearth schemes to
siphon off funds, launder money and even bribe
government officials (see “The
CPA’s Role in Fighting Money Laundering,”
JofA, Jun.01, page 26). Both
businesses and government bodies engage CPAs to
ferret out corruption and install competitive
bidding systems, ensuring that goods and services
under contract are needed, priced fairly and
actually delivered—making it harder for
bid-rigging, kickbacks and graft to occur.

Where do companies find the CPA experts? Ghezzi
markets her services through state CPA societies
and the Association of Certified Fraud Examiners.
“My work comes through word of mouth and
referrals,” says Paul Regan, CPA, certified fraud
examiner from Hemming Morse Inc. in San Francisco,
whose assignments have included the Miniscribe and
Sunbeam investigations. Often companies against
whom Regan has testified have enlisted his
services for subsequent engagements. Once a
company has selected the litigation consultant,
typically it is the corporate general counsel’s
office that hires the individual or CPA firm.

Many regional CPA firms and consulting
companies that specialize in forensic accounting
and litigation services are adding preventive work
to their portfolio. “We’re seeing increased
interest from companies that want to limit their
exposure to potential fraud and manage their
risk,” says Diane Womack, CPA, director in the New
York office of FTI Consulting, an Annapolis,
Maryland-based consultancy specializing in
financial and litigation advisory services. “More
companies are taking preemptive steps to detect
problems early rather than waiting for them to
develop,” says Womack. How does a company know it
got its money’s worth of risk reduction services?
The litigation expert achieves success when the
client doesn’t get sued.

Are you working with the best technology? Do you know how to help your clients determine if their technology stack measures up? In this free report, J. Carlton Collins, CPA, explains how to answer those questions via a technology assessment engagement.